How Equitable Wealth Outcomes Could Create a Resilient and Larger Economy

This post is the second in a four-part series titled “The State of Economic Equity.” Written by Institute for Economic Equity staff, this series examines the challenges facing vulnerable workers in 2023 and the opportunities that more equitable participation in the economy may provide.

Wealth, or net worth, is instrumental in advancing the financial stability of households and communities. For example, wealth serves as a form of self-insurance against life’s unexpected setbacks. It also allows people to make important investments, such as paying for college, purchasing a home or starting a small business. These investments, in turn, can help fuel economic growth.

Yet, the ability to accumulate wealth varies significantly by a household’s demographics. Our research has shown that younger generations, families without a four-year college degree, and Black and Hispanic families typically have less wealth than their peers.The demographic characteristics of households are sourced from responses to the Survey of Consumer Finances. Thus, if a respondent has a four-year college degree, the household is assigned that educational attainment. These groups’ representation ranges from roughly a quarter (Black and Hispanic) to two-thirds (those without a four-year degree) of U.S. households.

Research suggests that persistent economic gaps (e.g., inequities in employment and earnings) limit the ability of the economy to grow to its full potential. Understanding and removing barriers to more equitable employment outcomes may foster a more resilient and dynamic economy. In this blog post, we look at equity from a different perspective. Rather than focus on the labor market, we highlight how expanding the opportunity to build wealth has the potential to spur personal consumption and innovation, both of which can help strengthen the economy.

Economic Growth Can Spring from Wealth Equity

Wealth equity can be defined as the state in which all households, regardless of demographic identity, have the opportunity to accumulate enough wealth to ensure both short-term stability and long-term economic mobility. Greater wealth equity—that is, expanding the opportunity to build wealth—can allow more families to thrive instead of merely survive. Why are more-equitable wealth outcomes important generally? For one, because the state of household wealth can exert a powerful influence over the economy.

Wealth generated by households can collectively impact economic growth. Real gross domestic product (GDP) is the standard measure of economic growth. At approximately 70% of GDP, personal consumption expenditures—the goods and services people buy—are the largest component of the U.S. economy. As their wealth increases, households feel richer, so they typically spend more; this “wealth effect” can boost economic growth. Conversely, as their wealth declines, households tend to cut back on spending, which lowers aggregate consumption and consequently economic growth.

Both sides of the wealth effect were present leading up to and after the Great Recession (2007-09), which was precipitated by the housing bubble. Because housing is often the largest asset held by households, the wealth effect can be driven by fluctuations in house prices.

The bursting of the housing bubble and the accompanying financial crisis resulted in U.S. households losing approximately $8.3 trillion in wealth (including home equity and other types of wealth, such as financial assets), between the third quarter of 2007 and the second quarter of 2010. Beyond just a decline in house values, approximately 3.8 million homes were foreclosed on, erasing the home equity those homeowners had accrued up to that time. Further, Black and Hispanic homeowners struggled more than their white peers with higher rates of loan delinquencies and default during and after this period. This widespread wealth destruction triggered a balance sheet recession during which consumption weakened as households tried to rebuild their finances. This episode illustrates that changes in wealth can have a powerful influence over the economy.

Wealth Equity Could Help Mitigate Economic Downturns and Drive Growth in Expansions

Greater wealth equity could help mitigate economic declines and boost the economy (PDF) during expansions. During an economic contraction, more financially stable families would have funds to fall back on if facing a job loss or a decline in asset values. This means that many families wouldn’t need to heavily rely on the support provided by the public safety net (e.g., unemployment insurance). During times of expansion, greater wealth equity could drive consumption (via the wealth effect) and investment even higher, thus boosting economic growth.

However, to achieve greater wealth equity, many families need greater capacity to build savings and access to sustainable asset ownership (e.g., homeownership, tax-advantaged retirement accounts). Additionally, addressing inequities in wealth outcomes could lead to more opportunities for families of different demographic groups to invest in their futures and thrive.

Wealth Equity Could Unlock Broader Economic Innovation

Greater wealth equity could also serve to increase innovation in the overall economy. Innovation can take many forms for individuals, whether by seeking a STEM career that could lead to a technological breakthrough, or creating a community service organization that develops a new way to support low-income working families. Unleashing these pursuits may benefit families, their neighborhoods and the economy. However, big ideas often require two things: 1) financial stability and 2) the means to invest in oneself and one’s passion. Wealth equity can facilitate the ability of more individuals and families to take risks in the hope of attaining upward mobility.

Wealth creates different “ways of life.” In addition to greater financial stability, families and individuals who are wealthier have more opportunities for upward mobility and innovation. For example, wealth can facilitate greater innovation by providing the necessary startup resources for entrepreneurs and a cushion should things not go as planned. These investments, in turn, can contribute to broader economic growth. For a hypothetical case, see the example at the end of this post.

Wealth Trends in the Year Ahead

Federal stimulus measures during the pandemic (e.g., economic impact payments) and stronger-than-expected appreciation in housing and financial assets led to historically high levels of household wealth in the second quarter of 2020, and these wealth levels continued to reach new highs through the fourth quarter of 2021. Individuals with lower incomes benefited greatly from the stimulus measures and their wealth was fairly stable during first year of the pandemic. Higher-income groups saw the largest gains in average wealth in large part due to strong stock market performance (high-income groups own a disproportionate amount of equities). However, the stimulus has since ended, and growth in the housing and stock markets had cooled by the end of 2022. At the same time, consumers have taken on greater amounts of debt, especially credit card debt. Based on these trends, it’s unclear whether broad-based household wealth gains will remain or whether wealth accumulation may be hindered for those that are more financially constrained. If measures of wealth equity worsen, this may serve as a headwind to broader economic growth.

Given the broader economic benefits to be gained from more equitable wealth outcomes, the Institute for Economic Equity will continue its documentation of how wealth is distributed in the U.S. Part of the Institute’s past work described the evolution of wealth inequality in America. We will be updating this work after the release of the Federal Reserve Board’s Survey of Consumer Finances (SCF) for 2022; the SCF provides the most comprehensive data set on families’ wealth in the U.S. Further, we will release quarterly updates on demographic wealth trends through our Real State of Family Wealth.

The Transformative Power of Wealth: A Comparison of Two Hypothetical Families, the Chamberlains and the Halloways

Transcript: Economic Benefits from Greater Wealth Equity and Entrepreneurship

The Chamberlains and Halloways are both entrepreneurial families. While similar in many ways, the Chamberlains are wealthier than the Halloways. The Chamberlains own their home mortgage-free, while the Halloways just took out a 30-year mortgage. The adults in both families work at quality jobs. Both families have entrepreneurial dreams.

The Chamberlain family wants to start a coffee business so they take a risk and borrow against the equity in their home. They have enough for the startup costs of the business, and Brick Coffee is born. The family has sufficient resources for the adults to leave their jobs and focus solely on the new business. Brick Coffee becomes successful. The economy benefits from the small business, and the Chamberlains have an even stronger financial position.

The Halloway family dreams of starting a bakery. However, they don’t have the necessary networks or assets to cover the startup funds. Also, the adults can’t leave their current jobs without reducing the family’s income they rely upon. Furthermore, it’s difficult to save for a dream when more concrete realities take priority, like the mortgage and the children’s education.

Therein lies the great difference between the Chamberlains and the Halloways. The Chamberlains were able to take a risk. The Halloways, however, were unable to even try. The Halloways did not become entrepreneurs and the economy missed out on the potential contributions.

Wealth equity can increase economic growth, encourage consumption and boost innovation. Learn about the importance of building a more equitable economy right here at stlouisfed.org.

Produced by the Federal Reserve Bank of St Louis. Central to America’s Economy.

The Chamberlains and Halloways are both entrepreneurial families. While similar in many ways, the Chamberlains are wealthy and the Halloways are not. Each family is made up of a married couple with two children. The adults in both families work at good jobs. The Chamberlains own their home mortgage-free, while the Halloways just took out a 30-year mortgage. Both families have entrepreneurial hopes:

• The Chamberlain family wants to start a coffee business, so they take a risk and borrow against the equity in their home. They have enough for the startup costs of the business, and Brick Coffee is born. The family has sufficient resources for the adults to leave their jobs and focus solely on the brew. Brick Coffee becomes successful, the economy benefits from this small business, and the Chamberlains have an even stronger financial position.
• The Halloway family dreams of starting a bakery. However, they don’t have the necessary networks or assets to cover the startup funds. The adults also can’t leave their current jobs without reducing the family’s income they rely upon. Furthermore, it’s difficult to save for a dream when more concrete realities—the mortgage, the children’s education—take priority.

Therein lies the great difference between the Chamberlains and Halloways: The Chamberlains were able to take a risk; the Halloways, however, were unable to even try. The Halloways did not become entrepreneurs, and the economy missed out on their potential contributions.

Note

1. The demographic characteristics of households are sourced from responses to the Survey of Consumer Finances. Thus, if a respondent has a four-year college degree, the household is assigned that educational attainment.